Chartered Financial Analyst Level 2

Explanation

Under a constant dividend payout ratio policy, companies pay out a fixed percentage of earnings as dividends each period. This means:

• Dividends fluctuate with earnings: When earnings increase, dividends increase; when earnings decrease, dividends decrease
• Short-term volatility: Dividends become more volatile in the short term as they directly follow earnings fluctuations
• More uncertainty: Shareholders face greater uncertainty about future dividend payments

In contrast, a stable dividend policy aims to maintain relatively constant dividend payments regardless of short-term earnings fluctuations, providing more predictability for shareholders.

Option A describes a residual dividend policy where companies gradually adjust toward a target payout ratio over time.

Option C is incorrect because constant payout ratio actually creates more uncertainty about future dividends, not less.

Therefore, Option B is correct - a constant dividend payout ratio policy would most likely result in dividends fluctuating with earnings in the short term.